Sampo Group Risk Management Principles. 9 May 2018

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1 Sampo Group Risk Management Principles 9 May 2018

2 Table of contents 1. The Objectives, Tasks and Motivation of the Risk Management Process 4 2. General Group Level Risk Statements Risk Appetite Risks and Capital Management Division of Responsibilities 8 3. Risk Management Organisation Risk Management Governance Framework Sampo plc s Board of Directors Audit Committee Subsidiary Companies Board of Directors Subsidiaries Risk Committees Group Chief Risk Officer Risk Reporting Regular Risk Reporting Non-regular Risk Reporting 12 Appendix 1: Risk definitions 14 Appendix 2: Internal Capital Adequacy and Liquidity Assessment Process 19 Appendix 3: Management of Operational Risks 21 Appendix 4: Sampo Group s Single Own Risk and Solvency Assessment ( ORSA ) Policy 22 Appendix 5: Examples of Non-regular Reporting 25 2

3 Risk Management Principles Approved by Sampo plc Board of Directors on 9 May 2018 Scope of Application With these general guidelines, Sampo s Board of Directors confirms the underlying principles regarding risk management and internal supervision within the Sampo Group companies. Sampo s Board of Directors requires that all activities involving the exposure of any Sampo Group company to risks, as well as all activities controlling those risks, are arranged to comply with these general guidelines and related instructions, especially instructions and policies regarding remuneration provided by the Board, as well as with applicable legislation and regulations. The Board of Directors will supervise the risk taking and risk control activities in a manner deemed appropriate to ensure full compliance. The principles laid down herein apply to all Sampo Group companies*. Sampo plc s subsidiaries company specific policy and governance documents should follow these principles, taking, however, into account the requirements of different jurisdictions where they operate in and other specific requirements of the business. Company specific policies must cover specifically areas mentioned in Article 44 of Directive 2009/138/EC of the European Parliament and of the Council of 25 November 2009 on the taking-up and pursuit of the business of Insurance and Reinsurance (Solvency II directive) In case of conflict between these principles and locally binding set of rules, the locally binding set of rules prevails and company specific risk management policies shall be aligned with normative requirements. Paragraphs 3.1, 3.4 and 3.5 in Section 3 ( Risk Management Organisation ) are reflecting subsidiaries current decisions on risk governance and are not group-level guidelines. * Topdanmark A/S became part of Sampo Group as of 30 September 2017, Topdanmark s integration to Sampo Group s general governance and internal control framework, including risk management, is advancing according to plans, but it is not yet fully compatible with the principles set forth herein. 3

4 1. The Objectives, Tasks and Motivation of the Risk Management Process For financial sector companies in general, the core competences of business are skilful pricing of risks inherent in business operations and proper management of arising risk-exposures. A high quality risk management process regarding these risks is a necessary prerequisite of a going concern. Independent risk management functions in each Sampo Group company are responsible for risk management processes within the company, and this document covers principles for managing the aforementioned risks. Good reputation is of paramount importance for companies in the financial sector. Reputational risk realizes as a loss of confidence in the integrity of the institution among its stakeholders. Since the confidence of our stakeholders towards us is the basis for our longterm profitability, the tools to protect it must be diverse and embedded in the corporate culture. Core values behind the corporate culture are set in Sampo Group s Code of Conduct document that shall be complied with by all Sampo Group employees. Line management in all business areas is responsible for that all their subordinates understand the importance of reputation to Sampo Group, while all employees within the Group are responsible for arranging their work in a way where Sampo Group s reputation is safeguarded as efficiently as possible, but not at any cost. Each group company s executive management shall ensure that events threatening reputation are always reported in a timely manner to the company s Board of Directors and to the parent company in cases when realized event might affect the whole Sampo Group. Strategic risks have crucial role in the future success of each company. Since the management of those risks is the responsibility of the executive level senior management, only the definition of strategic risks has been covered in these principles. In Sampo Group, the key objectives of risk management are: Balance between risks, capital and earnings to ensure that risks affecting profitability as well as other material risks are identified, assessed and analysed; to ensure that capitalisation is adequate in terms of current risks inherent in business activities and strategic risks, taking into account the expected profitability of the businesses; to ensure that risk bearing capacity is allocated into different business areas in accordance with the strategy; and to ensure that underwriting risks are priced reflecting their inherent risk levels, and that expected returns of investment activities are in balance with their risks and consequential risks are mitigated sufficiently. Cost efficient and high quality processes to ensure that client service processes, internal operative processes and external reporting are cost efficient and of high quality; to ensure that decision making is based on accurate, adequate and timely information; and to ensure continuity of operations and fast and comprehensive recovery in case of discontinuity events. 4

5 Strategic and operational flexibility to ensure that external risk drivers and potential strategic risks are identified and the company is in a good position, in terms of capital structure and management skills, to react to changes in business environment; and to ensure that corporate structure, knowledge and processes in companies facilitate effective implementation of changes. When the above targets are met, risk management is contributing positively on return on equity and mitigating the yearly fluctuations in profitability. Risk management by assuring maintenance of supervisory authorities and other stakeholders confidence in Sampo Group is also contributing positively on reputation. The risk management process is therefore considered to be one of the contributors in creating value for the shareholders of Sampo plc. To meet these objectives Sampo s risk management process shall include following prerequisites and tasks. The central prerequisites to be in place for facilitating successful risk management are as follows: Risk management governance structure and authorisations (see Section 3, Risk Management Organization) and clear division of responsibilities between business lines and independent functions Companies own risk policies and more detailed instructions related to risk management. Prudent valuation, risk measurement and reporting procedures The central tasks of risk management process are as follows: Identification of Risks: The risks involved in business operations and business environment, are monitored continuously together with earnings potential. In particular, when new services are launched or business environment is changing, earnings potential and risks including reputational risks shall be thoroughly analysed. Risks, which Sampo Group companies face, are defined in Appendix 1 (Risk definitions). Assessment of Capital Need. The capital need to cover measured risks, risk based capital, is assessed and analysed regularly by risk types and over risks and business areas. In addition management considers the size of the buffer that is put over risk based capital to get actual amount of capital. Capital Management process is defined in Appendix 2 (Internal Capital Adequacy and Liquidity Assessment Process). Pricing of Risks: Sound pricing of customer transactions and careful risk/return consideration of investments is the prerequisite for achieving the targeted financial performance and profitability over time. In general, starting points of insurance policy pricing and investment decisions are (i) adequate expected return on allocated capital and (ii) operating costs. Managing Risk Exposures, Capital Positions and Operative Processes: The risks of insurance liabilities, investment portfolios and operative processes and capital positions are adjusted to maintain a sound risk to return ratio and return on capital (ROC). Management s responsibilities and authorisations are defined on separate documents, e.g. underwriting and investment policies. In addition to internal adjustments of risks and capital, companies can transfer risks to external parties by using derivatives and reinsurance contracts. Measuring and Reporting of Risks: Results, risks, profitability and needed capitalisation are measured, analysed and reported by Finance and Risk Management units, which are independent from business activities. 5

6 A high quality and transparently communicated risk management process facilitates the creation of shareholder value for the following reasons: Clients get a reliable service from a reputable institution and they feel confident when their client relationships are managed in a diligent and prudent manner, with an effective risk management; Risk premium required by investors and counterparties will be smaller when risks are transparent and the risk management process is clearly described and communicated; The motivation of the personnel strengthens when strategies, authorisations, limits, targeted return and reward criteria are clearly defined and communicated; and Supervisory Authorities confidence in company s ability to control the risks associated with its activities further bolsters co-operation with the authorities. 6

7 2. General Group Level Risk Statements 2.1 Risk Appetite Cost-efficient customer business soundly priced in terms of risks and adding value to our clients is the primary source of Sampo Group s profits and hence shareholder value. Customer transactions implementing the business strategy on the one hand and investment portfolios on the other hand, are the major sources of companies risk exposures. Over time, majority of the risk bearing capacity as an average is allocated accordingly. Sampo Group is an active participant in financial sector consolidation and disruption processes, driven by the ever faster progressing digitalisation, in the Nordic area. When strategic opportunities appear, they are considered separately and decisions including allocation of risk bearing capacity and changes in capital structure are made separately by Sampo plc s Board of Directors. As a result, a considerable amount of risk capital and funding may be allocated into strategic arrangements. Non-strategic or otherwise unnecessary balance sheet items will be disposed of and the released capital and reserves will be distributed to the parent company as appropriate. In addition to the ability to provide value-adding services for its clients and sound capitalization, the confidence of the clients and other stakeholders is among the most significant assets of Sampo Group. This is why Sampo Group shall arrange, but not at whatever cost, its activities in ways that safeguard Group s reputation. 2.2 Risks and Capital Management As a general rule, the actual amount of capital - solvency capital and other items absorbing economic losses - is maintained above both the internally assessed need for capital, or risk based capital, and the capital amount required by rating agency for target rating set by the company itself based on justifiable business considerations. The difference between the actual amount of capital and self-defined capital need, i.e. the desired buffer, is defined while deciding on the capitalisation targets of various group companies and the group as a whole (for more details, see Appendix 2 (Internal Capital Adequacy and Liquidity Assessment Process). As a rule, any potential excess capital (i.e. the actual capital in excess of the target capital) in any group company is transferred into the parent company, which, respectively, also provides capital injections to subsidiaries, if needed. The balance between risks and actual level of capital is analysed and monitored regularly assuming historical circumstances and, from time to time, different stress scenarios defined by the management. When a potential imbalance between risks and actual level of capitalisation is identified, balance will be secured by adjusting existing risk exposures, capital or both. In general, Sampo Group believes that maintaining the profitability of businesses and active adjustment of risks is the first line of defence in risk management and, in a long run, even more important factor than capitalisation. In addition to above principles of sub-group (or individual company) capitalization, the following principles shall be followed at group level: (i) proactive prevention of risk concentrations, (ii) no cross-capitalization between sub-groups in normal course of business, and (iii) the maintaining of liquidity generation capacity of the parent company. 7

8 2.3 Division of Responsibilities The focus is on the sub-group and company-level management of assets and liabilities, earnings, risks and capitalisation. In addition, group-level risk accumulations and concentrations are (i) prevented by organizing the division of responsibilities carefully between the companies, (ii) monitored regularly in Audit Committee, and (iii) managed by adjusting aggregated risks where necessary. The subsidiaries line organisations are in charge of pricing their products and services and organising their sales and implementation processes, for ensuring the profitability, efficiency, quality, security and continuity of their operations as well as the liability towards the clients. Companies can outsource their functions where they deem it efficient, while bearing into mind that core business functions, being critical success factors, shall not, as a main rule, be outsourced outside Sampo Group. If certain activities are outsourced the relevant Sampo Group company nevertheless always carries the ultimate responsibility and risks of the outsourced operation. The group companies engaged in outsourcing activities shall ensure that they comply with the relevant regulation and authorities instructions/ recommendations regarding outsourcing, and are encouraged to maintain an outsourcing policy that shall be complied with in all outsourcing arrangements. Investments, liquidity management and capital transactions are coordinated by parent company and conducted centrally by Investment Units. Group level reporting of financial results and risks are the responsibility of Sampo plc s Finance and Risk Control units, which are independent from business operations. Most of the risk management activities are performed by the subsidiaries, which are required to organize their risk management activities - identification, assessment, measurement, monitoring and adjustment within the principles and definitions described in this guideline and within the return and capitalisation targets approved by Sampo plc s Board of Directors. Companies will decide on company-specific risk policies and their risk reporting to management committees and their Board of Directors independently within their internal governance structure. However, they are also responsible for reporting of risks to the Group CRO, as authorised by Audit Committee, as defined by Group CRO (see section 4). 8

9 3. Risk Management Organisation 3.1 Risk Management Governance Framework Independent and separately managed Sampo Group companies organize their business activities, internal control and risk management process according to group-wide principles of which the most important are Code of Conduct, Internal Control Policy, Risk Management Principles, Remuneration Principles, Compliance Principles and Disclosure Policy. They approve their own more detailed policies and instructions and organize their reporting to management bodies by themselves. However, they have also group-wide reporting responsibilities that are, to the extent applicable, both in line with (i) the requirements in European Insurance and Occupational Pensions Authority EIOPA s guidelines for System of Governance and (ii) the internal requirements within Sampo Group, as defined in section 4. Reporting must take into account the specific features of companies business activities and their business environment. Sampo plc Board of Directors Sampo plc Audit Committee Group CRO If P&C Board of Directors Mandatum Life Board of Directors Topdanmark Board of Directors ORSA Committee Underwriting Committee Actuarial Committee Reinsurance Committee Reinsurance Security Committee Operational Risk Committee Internal Model Committee Ethics Committee Investment Control Committee Mandatum Life Risk Management Committee Insurance Risk Committee Operational Risk Committee Legal and Compliance Unit Business and Reputational Issues Baltic and Luxembourg Asset and Liability Committee Risk Management Committee Risk Management Function Model Committee Compliance Function Compliance Function 9

10 3.2 Sampo plc s Board of Directors Sampo plc s Board of Directors makes decisions regarding group-level risk management principles and other general guidelines. Risk management activities and internal control will be organised in accordance with the decisions of the Board of Directors; makes decisions on group strategies and sets high-level limits for risk-taking of subsidiaries; makes decisions on overall guidelines regarding capital allocations and target returns; makes decisions on key monitoring principles (such as risk measurement and performance calculation); and appoints an Audit Committee. 3.3 Audit Committee Sampo plc s Board of Directors has established an Audit Committee, of which duties related to risk management and internal control are defined in Audit Committee s Rules of Procedure as confirmed by Sampo plc s Board of Directors. 3.4 Subsidiary Companies Boards of Directors Subsidiary Companies Boards of Directors within their decision making authority, organise the business activities of the subsidiaries to implement strategic decisions made by Sampo plc s Board of Directors; make decisions on specific risk-taking policies, capitalisation, risk limits and the delegation of authorisations within the framework provided by approved Sampo Guidelines or otherwise binding decisions by Sampo s Board of Directors; control risks subject to capital requirements and capitalisation and be in charge of regulatory solvency and internally assessed solvency at all times; appoint persons to specific committees (among others underwriting, investment and operational risk committees, as deemed appropriate) and approves the policies and plans prepared by them; make decisions on policies regarding the management of operational risks and supervise their implementation; make decisions regarding the calculation principles for life and non-life insurance products and supervise their implementation; make decisions regarding the principles on reinsurance coverage of life and non-life insurance policies and supervise their implementation; and must ensure that all critical processes - client services, internal processes and external reporting - have clear ownership that include responsibility to maintain high quality of these processes to mitigate reputational threats. Especially IT, applications and systems used and data management practices should be areas of focus. 10

11 3.5 Subsidiaries Risk Committees If P&C Holding s and its subsidiaries Board of Directors and Mandatum Life s Board of Directors have each appointed separate committees with specified duties and tasks. In If P&C all risks are monitored in If s Own Risk and Solvency Assessment Committee (ORSA) chaired by If P&C Insurance Holding s Managing Director. The separate risk committees in IF P&C reporting to the ORSA are the Actuarial Committee, Underwriting Committee, Reinsurance Committee, Reinsurance Security Committee, Investment Control Committee, Ethics Committee, Internal Model Committee and Operational Risk Committee. The Chairman of each committee is responsible for organizing the required reporting to the ORSA. In addition there is Compliance Committee reporting directly to IF P&C Board of Directors. In Mandatum Life risks are monitored in Risk Management Committee (RMC) chaired by Mandatum Life s Managing Director. The separate risk committees reporting to RMC are Asset and Liability Committees, Insurance Risk Committee and Operational Risk Committee. In addition, in legal and compliance issues, business and reputation risks and business issues regarding the Baltic countries are reported to RMC by responsible line organisations. Topdanmark s risks are monitored by risk management function. It reports to the Risk Committee, which is responsible for risk policies, risk limits, solvency calculation, capital plans, own risk and solvency assessment (ORSA), and partial, internal model for non-life insurance risks. The Risk Committee has set up the Model Committee, which is responsible for developing and operating Topdanmark s internal model. The members of the Risk Committee are the CFO of the Group, the head of the Compliance Function and the heads of the primary risk areas, which are: Asset Management, Statistical Services, Reinsurance, Finance, Life Actuarial Services and Life Finance. The Risk Committee reports and recommends to the Board of Directors via the Executive Board. Sampo plc s investment activity and related risk management is governed by Sampo plc s Balance Sheet Policy. 3.6 Group Chief Risk Officer Scope of Responsibility: Secure a holistic view of the risks Sampo Group is exposed to, including monitoring and measuring Sampo s aggregated risk exposure as appropriate; Co-ordinate the risk management work within the group; Co-ordinate and monitor company specific and group-level risk reporting; Conduct continuous independent risk analysis based on available risk reporting; and Suggest changes in policies, guidelines and instructions related to risk management. 11

12 4. Risk Reporting 4.1 Regular Risk Reporting At group-level profits, risks and capital are reported at least quarterly and reporting shall mainly be based on reporting undertaken in sub-groups. In addition to reports covering subgroups, group-level risk concentrations shall be monitored separately. Also parent company s capacity to generate liquidity shall be covered in the reporting. The Group CRO, authorised by Audit Committee, must receive at least quarterly risk reports covering all relevant risks. Regular risk reports provide the Group CRO with aggregate and analyzed information about the risks defined in Appendix 1 and these reports are basis for group-level risk analysis prepared for Audit Committee. Group CRO maintains a list of reports to be provided regularly by all group companies. Group CRO together with group companies risk management functions is responsible for continuously developing contents of regular reports. For more details of risk reporting procedures, see Appendix 4 (Sampo Group s Single Own Risk and Solvency Assessment ( ORSA ) Policy). 4.2 Non-regular Risk Reporting In addition to regular risk reports, there are two kind of other risk reports: 1. Group CRO requests: Group CRO may ask companies to prepare an analysis/review on subjects that need special attention. The purpose of these reports is to deepen Sampo Group s understanding of the subject in question and the risks related thereto. Based on the report provided, the Group CRO together with the relevant company shall analyze whether there is need for actions to mitigate the possible risks. 2. Severe incidents: The purpose of incident reporting procedure is to enable Group management s preparedness for mitigating actions. Additionally, it contributes to ensuring that all employees understand the significance of reputation to all Sampo Group companies and the provisions of the Code of Conduct that apply to all Sampo Group employees. Group companies, based on their established reporting practices, shall inform their Board of Directors on realized risk events and/or identified threats, which may (i) cause significant financial losses directly or indirectly and/or (ii) threaten the reputation of the company, immediately after becoming aware of them. Rapid provision of all then available information is of essence for the Board s capability to contemplate appropriate risk management actions, if any. If the incident potentially affects the reputation and/or financial standing of the entire Sampo Group and/or Sampo plc, the CRO of the company, or the person nominated by him/her at his/her absence, shall inform immediately also Group IR, Compliance and Risk Management. 12

13 Prudent analysis and a report of the incident shall be made without delay after the relevant parties have been informed about it. The CRO of the company, or his/her order, is responsible for delivering the report to their Board of Directors and the Group CRO. The company together with the Group CRO shall then analyze the severity of the event and whether there is a need for reporting to any authority and/or to Sampo Group Audit Committee. If no authority and/or Audit Committee reporting is needed, the event shall be covered in the regular reporting in accordance with section 4.1. Group CRO also maintains a non-comprehensive list of events causing a reporting obligation to Group IR, Compliance and Risk Management (Appendix 5 (Examples of Non-regular Reporting)). The specific form of reporting shall be agreed between the relevant organizations. 13

14 Appendix 1 Risk Definitions From risk management s perspective, risk in business operations can be defined as the probability of adverse development leading to the result of the operations being worse than expected. When managing the risks, relevant is to be able to identify, quantify and adjust risks so that the negative consequences of risks (i.e. losses or decreased profits) are within toleration limits and that earnings potential justifies chosen risk exposures. Risks can be classified in many ways. In Sampo Group the risks associated with business activities fall by definition into three main categories: (i) strategic risks, (ii) reputational risks and (iii) risks inherent in business operations. Within those main categories risks are categorized mainly by underlying risk sources. The (potential) concentration of any particular risk is, as such, not specified as an own risk type. 1. Strategic Risks Strategic risk is the risk of losses due to changes in the competitive environment and/or lack of internal operational flexibility. Unexpected changes in general business environment can cause larger than expected fluctuations in financial results and in a long run they can endanger the existence of Sampo Group s business models. External drivers behind such changes are varied, including for instance general economic development, changes in commonly shared values, development of the institutional and physical environment and technological innovations. External drivers are often connected to each other in many ways and because of them customer demand and behaviour can change, new competitors may emerge and, as a result, business models of the industry can change. Currently the themes of sustainable business practices in general and especially the issues related to environment, society and governance, are changing the preferences and values of different stakeholders and, as a result, business environment is also changing in different ways. Due to the predominantly external nature of the drivers of and development in the competitive environment, managing strategic risks is the responsibility of the executive level senior management. Proactive strategic decision making is the central tool in managing strategic risks, which relate to the competitive advantage. The maintenance of internal operational flexibility i.e. the ability to adjust the business model and cost structure when needed is also an efficient tool in managing strategic risks. Although strategic risks are not covered by the capitalization process in Sampo Group, they may, however, have an effect on the amount and structure of actual capital base, if deemed prudent in existing business environment. 2. Reputational Risk Reputational risk refers to the risk that adverse publicity regarding the company s business practices or associations, whether accurate or not, causes a loss of confidence in the integrity of the institution. Reputational risk is often a consequence of a materialized operational or compliance risk and manifests often as a deterioration of reputation amongst customers and other stakeholders. Reputational risk is related to all other activities as well. As the roots of reputational risk are varied, the tools to prevent it must be diverse and embedded in the corporate culture. The corporate culture, which is based on the core values of ethicality, loyalty, openness and entrepreneurship, is thus seen as an essential tool in preventing reputational risk in Sampo 14

15 Group. These core values are reflected in how Sampo deals with environmental issues and its core stakeholders in society (i.e. customers, personnel, investors, other co-operation partners, tax and supervisory authorities) and how Sampo Group has organized its corporate governance system. 3. Risks Inherent in Business Operations The management of risks inherent in business operations earnings risks and consequential risks are the responsibility of the business areas and investment unit in decision-making sense, and at the same time, come under the supervision of independent risk control. 3.1 Earnings Risks In its underwriting and investment operations, Sampo Group is consciously taking certain risks in order to generate earnings. These earnings risks are selected carefully and managed actively. Underwriting risks are priced reflecting their inherent risk levels and the expected return of investments is compared to the related risks. Furthermore, earnings risk exposures are adjusted continuously and their impact on the capital need is assessed regularly. Successful management of underwriting risks and investment portfolio risks is the main sources of earnings for Sampo Group companies. The day-to-day management of these risks i.e. maintaining them within given limits and authorisations, is the responsibility of the business areas and the investment unit(s). Non-Life Underwriting Risks Based on Solvency II regulation, underwriting risk in non-life insurance is often divided in premium risk and reserve risk in order to distinguish between the risks related to unexpired and expired contracts. Premium Risk relates to future claims resulting from expected insured events which have not occurred on or before the balance sheet date. The frequency, severity and timing of insured events and hence future claims may differ from those expected. As a result, the claims cost for future claims exceeds the expected level and there is a loss in financial accounting or adverse changes in the value of insurance liabilities. Catastrophe Risk can be seen as an extreme case of premium risk. It is the risk of extreme or exceptional events, such as natural catastrophes, where the pricing and setting of provisioning assumptions include significant uncertainty. These events may lead to significant deviations between actual claims and the total expected claims resulting into a loss or adverse changes in the value of insurance liabilities. Reserve Risk relates to incurred claims resulting from insured events which have occurred at or prior to the balance sheet date. The amount, frequency and timing of claim payments may differ from those originally expected. As a result, technical provisions are not sufficient to cover the cost for already incurred claims and there is a loss or adverse changes in the value of insurance liabilities. Life Underwriting Risks Biometric Risks refer to the risk that the company has to pay more mortality, disability or morbidity benefits than expected, or the company has to keep paying pension payments to the pension policy holder for a longer time (longevity risk) than expected at the time of pricing the policies. In life insurance, catastrophe events include as in non-life insurance rare single events, or series of events, usually over a short period of time and, albeit even less frequently, longer 15

16 lasting events. When a low frequency, high severity event or series of single events lead to a significant deviation in actual benefits and payments from the total expected payments, catastrophe risk, i.e. an extreme case of biometric risk, has realized. Behaviour Risks arise from the uncertainty related to behaviour of the policyholders. The policyholders have the right to cease paying premiums (lapse risk) and may have a possibility to interrupt their policies and withraw their savings (surrender risk). Expense Risk arises from the fact that the timing and/or the amount of incurred expenses related to management of insurance policies differs from those expected at the timing of pricing. As a result expense charges originally assumed may not be enough to cover the realized expenses. Market Risks Market Risks refer to fluctuations in the financial results and capital base caused by changes in market values of financial assets and liabilities, as well as by changes in the economic value of insurance liabilities. The changes in market values and economic values are caused by movements in underlying market variables such as interest rates, inflation, foreign exchange rates, credit spreads and share prices. Furthermore, market risks include also changes in the volatility of market variables, risk of worsening market liquidity in terms of widening bid-ask spreads and the risk of unexpected changes in repayment schedules of assets. In both cases the market value of financial instruments in investment portfolio may change. Risks and returns in different markets are considered when Sampo Group companies enter into investments or sell investments from investment portfolios. The fundamental distinction between market risks and underwriting risks is that relating to Market risks Sampo Group is in most cases a price taker and not a price giver. Market risks are the other major earnings risk for Sampo Group and good performance in this area is a critical success factor. The company is exposed to ALM Risk when changes in different market risk variables (e.g. interest rates, inflation, foreign exchange rates) cause a change in the fair values of investment assets and derivatives that is of different size than the respective change in the economic value of insurance liabilities. It has to be noted that the cash flows of insurance liabilities are modelled estimates and therefore uncertain in relation to both their timing and amount. This uncertainty is central component of ALM risk as well. On balance-sheet level, ALM risks contribute considerably to economic values, risks and the need for capital. To manage them, Sampo Group companies analyse and monitor ALM risks and ALM exposures actively and the risks are taken into account when designing the limit structures, managing investments within limits and authorisations and developing insurance products. 16

17 3.2 Consequential Risks Some risks are indirect repercussions of Sampo s normal business activities. They are one-sided risks, which in principle have no related earnings potential. Accordingly, risk management s objective is to mitigate these risks efficiently rather than actively manage them. The mitigation of consequential risks is the responsibility of the business areas and investment unit and the capital need for these risks is measured by independent risk management functions. Consequential risks can be categorized in three separate groups: (i) counterparty default risk of credit risk; (ii) liquidity risk; and (iii) operational risk. Credit Risk by definition comprises default, spread and settlement risks. Default risk refers to losses arising from occurred defaults of contractual counterparties (counterparty risk) or debtors (issuer risk). In case of counterparty risk, the final loss depends on the positive mark-to-market value of derivatives or reinsurance recoverables at the time of default, the value of collaterals and on the recovery rate in the eventual liquidation of the counterparty. In case of issuer risk the final loss depends on the investor s holding of the security or deposit at the time of default, mitigated by any potential recovery. Spread risk refers to losses resulting from changes in credit spreads of debt instruments and credit derivatives. Credit spreads are affected when the market s perception of probabilities of defaults is changing. In most cases, issuer risk has already been fully priced as a higher spread and respectively as a lower market value of security before the event of default has occurred. In essence credit spread is the market price of default risk for issued tradable instruments. Because of these features, spread-risk including also debt instrument defaults is categorized in Sampo Group under investment portfolio market risks. Settlement risk realizes when one party will fail to deliver the terms of a contract with another party at the time of settlement. Settlement risk can be the loss associated with default at settlement and any timing differences in settlement between the two parties. Settlement risks are mitigated effectively by centralized settlement and clearing systems used by Sampo Group companies. Liquidity Risk is the risk that Group companies are, due to lack of available liquid funds and/ or access to relevant markets, unable to conduct their regular business activities in accordance with the strategy, or in extreme cases, are unable to settle their financial obligations when they fall due. In Sampo Group Liquidity risk deals with potential illiquidity of investments, large claims and unexpected non-renewal of insurance policies. In addition, the availability and cost of refinancing and the offered price for financial derivatives affect the Group companies ability to carry out normal business activities. The sources of liquidity risk in Sampo Group are either internal or external by their nature. If the company s rating declines or if the company s solvency otherwise appears jeopardised, its ability to raise funding, sign reinsurance contracts or enter into financial derivatives at a reasonable price is endangered. Moreover, policyholders may also not be willing to renew their policies. If these risks caused by internal reasons realize simultaneously with general market turmoil making the selling of investment assets and refinancing of debt difficult maintaining adequate liquidity may be challenging. Sampo Group manages Liquidity risk by maintaining both parent company s and subsidiaries creditworthiness and reputation on appropriate level. Also, diversification of business operations exposed to liquidity risks is sought. In particular, the maturity diversification of expected cash flows generated from different business activities is under constant scrutiny. Since there is no unambiguous technique to quantify the capital need for liquidity risk, it is not directly taken into account in capital need estimates. Consequently, only the interest rate risk part of balance sheet level risks is accounted for in the economic capital framework. 17

18 Operational Risk refers to the risk of financial and/or reputational loss resulting from inadequate or failed processes or systems, from personnel or from external events. This definition includes legal risk but excludes risks resulting from strategic decisions. The risks may realise for instance as a consequence of internal misconduct; external misconduct; insufficient human resources management; insufficiencies in operating policies as far as customers, products or business activities are concerned; damage to physical property; interruption of activities and system failures; and defects in the operating process. Materialized operational risks can cause immediate negative impact on financial results due to additional costs or loss of earnings. In longer term materialized operational risks can lead to loss of reputation and, eventually, loss of customers, which endangers the company s ability to conduct business activities in accordance with the strategy. Compliance Risk is the risk of legal or regulatory sanctions, material financial losses, or loss of reputation, resulting from a company s failure to comply with laws, regulations and administrative orders applicable to its activities. Compliance Risk is usually a consequence of internal misconduct and hence it can be seen as a part of operational risk. The principles of managing operational risks in Sampo Group are presented in Appendix 3 (Management of Operational Risks) to this guideline. 18

19 Appendix 2 Internal Capital Adequacy and Liquidity Assessment In Sampo Group s business entities at sub-group and company level, the total need for capital (i.e. the actual amount of capital) is assessed regularly in two-step process as follows. Defining the Capital Floor Capital Floor is the minimum level of own funds the company needs to run its business operations normally. The amount of capital floor is the highest of the following three quantitative capital concepts: a. Solvency Capital requirement by regulatory Standard Formula; b. Solvency Capital requirement by company s Internal Model; and c. Rating Agency Capital, i.e. the capital needed to secure the target rating for the company. When the company is using internal model(s), the procedures shall be thoroughly validated and verified and model approved by its Board of Directors. Defining the Size of the Buffer Because risk exposures and profits evolve continuously over time and capital can sometimes erode rapidly due to stressed situations, there is a need to have a certain buffer, which together with the capital floor, as determined by the company in accordance with the above rule, form the actual amount of capital. An adequate buffer gives time for the company to adjust its risks and capital in a controlled manner in times of stress, i.e. at all the time maintain the balance between risks and capital. An adequate buffer also gives comfort to supervisors, clients, investors and counterparties of the company s reliability. The following factors are most material when the size of buffer is considered: Expected profits the higher the level of expected profits and the lower their volatility, the smaller the buffer that is needed; Business growth prospects - if business is growing the buffer is larger than in the case of a run-off business; Other sources of capital the more capacity and ability to issue S II compliant capital instruments means that a lower buffer is needed; and Uncertainty of measured SCR or other relevant capital requirement the bigger the uncertainty around the relevant capital requirement s ability to predict future capital needs, the bigger the buffer. 19

20 Group Level Considerations The primary focus is on the capitalization at the sub-group level and respective principles as described above shall be followed. When the sub-groups are well-capitalized, the whole group is by definition well-capitalized, except in cases where sub-groups are cross-capitalizing each other, the parent company is financially weak or profits of the sub-groups correlate both positively and strongly. Hence, from Sampo Group s perspective, the main objectives the achievement of which the management shall promote by all appropriate and feasible means are: Independent business areas generate a stable and growing stream of profits and have adequate solvency to ensure the continuity of normal business activities; The portfolio of separate business areas is stable. From group perspective, a weak correlation of business areas profits is preferred, increasing the benefits of diversification on portfolio level; Group s parent company is able to provide liquidity for strategic arrangements and capital injections, if needed. Hence, the parent company shall prefer to have a relatively low leverage and adequate liquidity buffers to ensure its ability to generate liquidity. Summary Sub-groups and their companies shall monitor the size of the capital buffer and have practices in place to maintain actual amount of capital always over the defined capital floor. There is no need to have a fixed Solvency Coverage Ratio target. The parent company shall monitor group-level issues such as risk concentrations, intragroup transactions, profit correlations etc. which have direct impact on the desired level of capitalization and shall maintain capital buffers and liquidity generation capacity (i.e. headroom in commercial paper and EMTN programmes combined with relatively low leverage) to facilitate responding to changes in the monitored issues. 20

21 Appendix 3 Management of Operational Risks The goals of operational risk management are: to ensure simultaneously the efficiency and quality of operations; to ensure that operations are compliant with laws and regulations; and to ensure the continuity of business operations in exceptional circumstances. Each company is responsible for arranging its operational risk management to align with above goals, taking also into account the specific features of its business activities. The central tools in operational risk management are (i) the identification of risks, (ii) proper preventive actions at all levels of operations and (iii) continuity planning. To ensure the use of these tools, responsibilities in the following areas must be set clearly: drafting and enforcement of adequate operational risk policies and continuity plans; legal and financial compliance of operations; continuous development of human resources (knowledge and skills) and work processes; day-to-day management; and reporting and controlling. Examples of areas where operational risk management is considered especially important are: Personnel. To perform their duties with skill and competence, personnel must have adequate experience for their work, as well as the required special skills and training. Also responsibilities and objectives of employees have to be clearly set, described and adequately communicated. Risk identification. Risks related to services and products offered should be identified to ensure the functionality of the sales, implementation and reporting processes. Risk identification is crucial when new businesses are launched or there are fundamental changes in the way business is conducted. Work processes. Work processes and user rights to IT systems have to be arranged in such a way that various parts of a process cannot be controlled by one person alone. The duties of individual employees must be organised and segregated accordingly. Moreover, the personnel should have user rights only to data and ICT systems they need for their duties. Ensuring the correctness of information. All information entered into data systems (either related to contractual / customer information or any other relevant information) must be sufficient in scope and accuracy. The accuracy of the information has to be verified using controlling methods appropriate for the business area in question. Security of Data and Information systems.. It must be ensured that data security of systems is sufficient and up-to-date. The correctness of calculated information. The calculation routines used both in internal (quantifying business development, performance and risks) and external reporting (all client and other stakeholder related reporting) must be verified and documented. Physical Property. Physical property and hardware are examples where continuity plans are needed. 21

22 Appendix 4 Sampo Group s Single Own Risk and Solvency Assessment ( ORSA ) Policy Approved by Sampo plc s Board of Directors on August 10, 2016 Background and Basis Once in a calendar year or more frequently, if required Sampo Group produces a single ORSA document ( Single ORSA ) for the group, covering all group companies subject to Solvency II regulation. This policy defines the general principles, processes and methods used when preparing the group s Single ORSA. Single ORSA aims at producing a forward looking view on the risks which Sampo Group is exposed. It also represents Sampo s own view of its risk profile, and the capital and other means needed to address those risks. The Single ORSA document shall include: (1) assessment of Sampo Group as a whole; (2) individual assessments of each of Sampo s sub-groups (i.e. If Group and Mandatum Life Group) and their group companies. Associated companies such as Nordea Bank AB and Topdanmark A/S shall also be taken into account at the ultimate group level, when group solvency is forecasted. The participation risk associated with these holdings will be based on the latest available public information at the time of the assessment. The associated companies are not covered in Sampo Group s Single ORSA in any other manner. The legal framework Sampo has chosen for Group s yearly risk and solvency assessment is the Act on Supervision of Financial and Insurance Conglomerates ( FICO Act, having its basis on Directive 2002/87/EC). The FICO Act prescribes the application of sectoral rules, i.e. Solvency II rules to insurance companies and Capital Requirements Regulation (CRR/CRD IV) to credit institutions and to Sampo plc. This approach doesn t take into account diversification effects between Sampo Group s business areas, and, consequently, is a conservative view on solvency, and is also the way Sampo Group has traditionally monitored its regulatory group level solvency. For the purpose of group level risk and solvency assessment, the subgroup information is used as a basis for consolidated analysis. Own risk and solvency assessment is an integral part of Sampo Group s risk management system. Processes and Procedures As a basic principle the Single ORSA shall correspond to the group s business model as described in Risk Management section of the Annual report. Accordingly, the first priority is to give a complete and detailed picture of the risks and capital at the sub-group level. Secondly, the same analysis shall be conducted at the company level. In the third phase, Sampo Group level solvency ratios shall be forecasted based on the subgroups and associated companies ( 1 risk and capital forecasts on a consolidated basis. Accordingly, the forecasts of each sub-group must be based on common group level scenarios given by the parent company. 1) Associated companies numbers are based on latest available public information at the time of the assessment. 22

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